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The investment prospects of gold mines – Part 1

An industy in decline, but might it still have some spark?

It is said that gold miners are in a ‘sunset industry’, fighting for their very survival. Is there any hope left? I would reason that it is possibly ‘darkest before dawn’ and that there is light. 

The definition of a ‘sunset industry’ is “An older industry that continues to be important to an economy but is losing favour with investors due to its steadily falling employment generation capacity and profits, and comparatively higher environmental costs.” This describes the gold mining industry perfectly.

My previous articles have focused on physical gold and its role in our economy. I have strongly advocated that the best way to protect oneself against the ravages of inflation and potential stock market loss through a correction is to hold some physical gold as your ‘insurance’. 

Read: Gold – overcoming the fear of rand strength

Furthermore, I indicated that between 5 and 10% of one’s portfolio should be invested in gold, of which the majority should be in Krugerrands, and that only the assertive investor should place a small portion of their assets in gold shares (the gold mines, with their gold resources still in the ground).

Read: When is the optimal time to buy gold?

Let’s then attempt to go underground and see how we can find out more about the gold mining industry. In particular, the gold that still needs to be discovered (exploration) and proven by geologists, through to the building of a mine and determining how best to access the ore body and deliver it for pouring.

Reasons not to invest in SA’s gold mining companies

* The sector has a notorious track record of underperforming the rest of the stock market.

* The future of South African mines has been unclear up to now due to the delayed revision of the much-needed Mining Charter.

* The new Mining Charter published in September requires that for the awarding of a mining licence, 30% of the mine needs to be owned by BEE candidates (‘previously disadvantaged people’). It was previously 26%. However, when approached for clarity on the issue of ‘once empowered, always empowered’ in the event that BEE owners sell their shares, the High Court ruled that there must always be “a recognition of previous transactions”.

* Labour strikes hold miners to ransom as unions demand higher wages and benefits.

* In the event of a mining accident, government shuts down the mine until a full investigation has been done. These delays lead to further financial loses.

The positive attributes of investing in gold mines

* In the 1970s gold mining accounted for 25% of South Africa’s GDP, its profits making a meaningful contribution to the coffers of the country, benefiting all concerned.

* Gold miners have traditionally been a big employer, helping to alleviate the unemployment problem.

* South Africa is known to have the best gold resources in the world. Unfortunately these resources are very deep in the ground and it is not feasible to mine for this gold at the current low prices.

* Should the gold price rise significantly, South Africa will be well positioned to benefit from this opportunity.

* There is a leveraging effect when the gold price increases: the basic mining costs remain the same, but as the gold price increases, so the profit margin escalates, possibly significantly, which can translate into a far higher share price.

What does the industry say about itself?

Roger Baxter, CEO of the Minerals Council (formerly the Chamber of Mines), represented South Africa at the Africa Down Under conference held at the end of August in Perth, Australia.

Baxter stated: “South Africa’s mining potential is huge. Even in the absence of a greenfields exploration boom in South Africa, mining investment could almost double in the next four years if the country was to return to the top 25% of the most attractive mining investment destinations worldwide.”

He aded: “This would result in another 200 000 jobs being created in the economy with 50 000 direct jobs created in mining alone … the mining industry would be in a better position to increase its contribution towards infrastructure development and social projects in mining-affected communities. Given the industry’s commitment to real transformation, this would also materially advance the entire country’s transformation agenda.”

From his slide presentation it is evident that the gold mining sector will benefit the most. It would add 29 000 jobs directly, more than double that of the next best, the coal sector, and its capital expenditure investment requirement is 40% less.

Source: Minerals Council South Africa

Why is the Minerals Council so upbeat?

The Minerals Council has constructively engaged with all stakeholders. It sees the strategy that will enable the South African mining industry to realise its potential.

Baxter outlined the key requirements:

  • A shared vision of the future of the mining industry
  • Ethical leadership and good governance
  • Policy and regulatory certainty and competitiveness
  • Infrastructure that is available, efficient, cost-competitive and reliable
  • Improved productivity and competitiveness, and
  • The creation of a ‘greenfields’ exploration boom.

The grounds for hope at country level?

Baxter points out that since Cyril Ramaphosa was sworn in as president of South Africa in February, there have been a number of reforms and changes aimed at addressing state capture, rooting out corruption and getting the economy back on track.

Ramaphosa has also made some key cabinet appointments, including the respected Gwede Mantashe as the minister of mineral resources, and the trusted Pravin Gordhan and Tito Mboweni as ministers of economics and finance respectively.

Thorns among the green shoots

Ramaphosa has yet to spell out his proposed land expropriation without compensation policy, an issue that is in great need of clarity.

The revised Mining Charter has, however, provided clarity on the way forward for this sector. The revisions are generally positive and will advance transformation of the industry while also facilitating growth and development.

Overall, the tide appears to be turning. The industry has addressed many of the concerns that have held back investment and growth. Could it be that now is the time to be investing in the sector, when evaluations are excellent and, relative to other assets such as stocks and the bond market, gold miners are offering superb value?

This appears to be one of the best buying opportunities in many years.

In Part 2 I will examine who the gold miners are and which are the best to buy.

David Melvill is an independent investment advisor based in Montagu in the Western Cape.

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COMMENTS   13

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My dear David = You cannot revive a dead horse !!

The Gold Mining Index chart seems to suggest their is “new life” breathed into this index. The chart is in FULL Bull mode.

The chart has made a strong ascent over the last 17 weeks, rising from its low of 920 to 1300 that is a massive 380 points or 41%.

Send me your email address and I will send you the chart. davidm@financialhub.co.za

Actually Gold is starting to look good for the following reasons,

1) US – China trade war,
2) US FED rates increase,
3) Talk of recession in the US by 2020,
4) Economic slowdown in China,
5) Economic slow down in the US in 2019,
6) Brexit – no deal,
7) France riots, Hungarian riots,
8) Goldman Sachs getting sued by Malaysia,
9) Ukraine/Russia tensions

Lots of fantasy land in this article.

Follow the gold miners money. Right now they’re like rats jumping off the sinking ship.

When that changes, then you’ll know the investment climate has turned positive.

No question that South Africa has been blessed with an abundance of resources but the scenario set out in this article is misleading and exaggerated . Deep level South African gold mines are a relic of the past and the remaining operating gold mines will simply limp on just to survive. Even if the unlikely event gold price increases sharply, investing in deep level exploration and long lead “Billion Rand Gold Mines” are at best a fairy tale. With reference to other near surface minerals new operations will create a relatively small number of jobs and generate marginally to the economy . Unless there is a dramatic change in the South African political climate the country is unlikely to compete with most other resource rich counties of the world.

The three link chain in any economy.
Number one is self supporting in majors as food and work.
Two, money strength depending on industrial demand, not rich men.
Three, a working force as total, not class.
Reading past headlines like reasons of Rand weakish should have been strength, if stuff like gold have to be exported.
looking for a Maserati, the complain, weakness, is justified.
Cost of living in today South Africa is now on par with most European country’s.
Making a mockery of the minimum wages of less as two Euro p/h.
Dreams of the coming investor paradise is in fact a fools one.

What WACC would you apply when valuing ZA gold miners? What does their FCF look like?
Is the entire investment premise based on the price of gold much higher than it is now (a Black Swan event), or can the industry somehow make fundamental changes to cost and productivity?
The following illustrates some of the specific issues with ZA gold mining:
1.) Gold price in ZAR has increased by 7% p/a over last 10 years;
2.) Electricity has increased by 350% since 2008 (about 13% p/a). Electricity is now 20% of cost;
3.) Wage increase of 4% above CPI on average over 10 years. Average of 10.3% p/a. Cumulative increase of 142% since 2008 to 2017. Wages make up 53% of the cost;
4.) Average productivity per employee is virtually unchanged (2009: 35oz/employee, 2017: 36oz/employee)
5.) South Africa’s gold mines are on average the most expensive in the world. SA average AISC at $1 035/oz compared to global average AISC of $818/oz
6.) 75% of the gold mines are unprofitable at an avg gold proice of R590,000/kg

http://www.goldwagenegotiations.co.za/facts-figures
http://www.scielo.org.za/scielo.php?script=sci_arttext&pid=S2225-62532016000300014

Good info here Lemon,

Since cost creep for mines is in excess of 10% p.a., the only savior of the gold industry would be a rare case of:

– rapid gold price increase (requires massive global inflation- unlikely)
– rapid depreciation of rand (a possibility)

Either has to be to tune of roughly >20% p.a to attract investment.

No problem if my comments were censored. All of them reported in the ”mainstream media” for many moons, anyway!

@ comme ci comme ca…what were those comments ? …we keen to know

Let me try and post again!

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